The network innovation review: our consultation proposals · The network innovation review: our...

Ofgem 9 Millbank, London SW1P 3GE www.ofgem.gov.uk

The network innovation review: our

consultation proposals

Consultation

Contact: Neil Copeland

Publication date: 1 December 2016 Team: Networks

Response deadline: 6 February 2017 Tel: 020 7901 7193

Email: [email protected]

Overview:

This consultation document is seeking stakeholders’ views on changes we are proposing to

the Network Innovation Allowance (NIA) and Network Innovation Competition (NIC). These

schemes operate in the gas and electricity network price controls to fund research and trial

projects for transitioning to a low carbon economy which bring benefits and value for money

for consumers.

We’ve reviewed the findings from an independent review of an earlier innovation

mechanism, and we’ve also carried out a post-implementation review of the governance

arrangements for running the schemes. As a result we are proposing several changes to the

schemes. We think there are significant opportunities to make the NIC and NIA even more

effective and further increase the value for money to consumers. Our proposals include

reducing the future level of funding available for the electricity NIC, options to increase the

involvement of third parties in the schemes, requiring a non-returnable contribution towards

project costs from network companies, as well as some other changes to reduce the

administrative burden of participating and running the gas and electricity innovation

schemes.

We are seeking stakeholders’ views to this consultation by 6 February 2017.

mailto:[email protected]

The network innovation review: our consultation proposals

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Context

Ofgem1 is the Office of Gas and Electricity Markets which regulates the electricity and

gas industries in Great Britain. Our principal duty is to protect the interests of

existing and future gas and electricity consumers.

One way in which we protect the interests of consumers is by regulating the network

companies though price controls. We set price controls to specify the services and

level of performance the network companies must provide, and to restrict the

amount of money the network companies can recover from consumers through

network charges. The energy system in Great Britain is undergoing rapid and significant change. As a

consequence, network-related costs could increase significantly from connecting

large volumes of generation, as well as managing the impacts of new generation

patterns on network operation. We think it is in consumers’ interests that the

network companies respond creatively to the challenges posed by these changes.

New approaches could deliver more efficient and timely services needed by network

customers and lessen the cost impact on consumers. This might be achieved, for

example, by developing and adopting new technology, different operational practices

and novel commercial arrangements.

Monopoly network companies don’t face strong incentives to focus on innovating. To

help encourage the companies to play a full role in exploring opportunities we put

innovation at forefront of the price control framework RIIO (Revenue = Incentives +

Innovation + Outputs). This framework was introduced for gas distribution

companies (RIIO GD1) and electricity and transmission companies (RIIO T1) in 2013

and for electricity distribution companies (RIIO ED1) in 2015.

In RIIO there is a time-limited innovation stimulus package to encourage the

network companies to adopt a more innovative culture. Two key mechanisms of the

package are the Network Innovation Allowance (NIA) and the Network Innovation

Competition (NIC). Together the schemes fund the companies to conduct research

and run network-related trial projects for transitioning to a low carbon economy,

where these offer cost savings and/or wider environmental benefits for customers.

The funding provided to companies under the schemes is paid for by consumers.

1 The terms ‘Ofgem’, ‘the Authority’, ‘we’ and ‘us’ are used interchangeably in this document.


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Associated documents

Reviewing the benefits of the Low Carbon Networks Fund and the governance of the

Network Innovation Competition and the Network Innovation Allowance, December

2015 consultation:

https://www.ofgem.gov.uk/sites/default/files/docs/151217_-

_two_year_review_open_letter_au.pdf

Network Innovation Competition Governance Documents:

https://www.ofgem.gov.uk/publications-and-updates/version-2-1-network-

innovation-competition-governance-documents

Network Innovation Allowance Governance Documents:

https://www.ofgem.gov.uk/publications-and-updates/version-two-network-

innovation-allowance-nia-governance-documents

EA Summary of Learning: https://www.ofgem.gov.uk/publications-and-updates/ea-

technology-s-summary-low-carbon-network-fund-learning

Poyry and Ricardo Energy evaluation report:

http://sharepoint2010/sgg/Transmission/tca/Transmission_Co_Authoring_Lib/Innova

tion/Reviews/september%202016%20consultation/Innovation%20Review%20consul

tation.pdf

https://www.ofgem.gov.uk/sites/default/files/docs/151217_-_two_year_review_open_letter_au.pdf

https://www.ofgem.gov.uk/sites/default/files/docs/151217_-_two_year_review_open_letter_au.pdf

https://www.ofgem.gov.uk/publications-and-updates/version-2-1-network-innovation-competition-governance-documents

https://www.ofgem.gov.uk/publications-and-updates/version-2-1-network-innovation-competition-governance-documents

https://www.ofgem.gov.uk/publications-and-updates/version-two-network-innovation-allowance-nia-governance-documents

https://www.ofgem.gov.uk/publications-and-updates/version-two-network-innovation-allowance-nia-governance-documents

https://www.ofgem.gov.uk/publications-and-updates/ea-technology-s-summary-low-carbon-network-fund-learning

https://www.ofgem.gov.uk/publications-and-updates/ea-technology-s-summary-low-carbon-network-fund-learning

http://sharepoint2010/sgg/Transmission/tca/Transmission_Co_Authoring_Lib/Innovation/Reviews/september%202016%20consultation/Innovation%20Review%20consultation.pdf




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Contents

Executive Summary 5

1. Background and scope of our review 8 Introduction 8 The need for innovation by network companies 8 Innovation within the RIIO framework 9 Scope of our innovation review and this consultation 10

2. Evaluation of the Low Carbon Network Fund 11 Introduction 11 Background to the LCNF 11 Why we’ve commissioned an evaluation of the LCNF 12 Scope of the independent evaluation 12 Key findings from evaluation 12 Recommendations from the evaluation 17

3. Proposals for delivering greater value for money 19 Introduction 19 Industry to develop a strategy for innovation 20 Increasing third party involvement 21 Removal of successful delivery reward 24 Removal of provision to recover bid preparation costs 24 Combined potential impact of our proposals 25 Timing of proposed changes 25

4. Proposal for future funding level of the electricity NIC 27 Introduction 27 How much funding should we make available? 27 Contribution from RIIO ED1 over 2017 - 2023 29

5. Other proposals for governance arrangements 30 Introduction 30 Reducing the burden of processing change requests for NIC projects 31 Improving the interpretation of the default intellectual property arrangements 32 Further assurance on project eligibility under NIA 33 Lower level changes we propose to the governance of NIC and NIA 33

6. Next steps 36

Appendices 37

Appendix 1 – Summary of responses to our December 2015 consultation 38

Appendix 2 - Feedback Questionnaire 41


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Executive Summary

In the past, monopoly network companies have generally undertaken less innovation

than is optimal. One reason for this is that cost savings resulting from innovations

are shared with consumers and lead to lower cost allowances in future price controls.

At a time when there is significant change in the energy system, the companies need

to be innovative to adapt networks to meet future challenges. They also need to get

the most out of their existing capacity. Innovation is critical for transitioning to a low

carbon economy at lowest cost to consumers.

The RIIO price control framework is designed to encourage the network companies

to innovate in the delivery of good value network services. For example, an 8 year

price control period means companies can benefit for longer by successfully

innovating. The price control also includes time-limited schemes to award funding to

the network companies for innovative projects. These are the Network Innovation

Competition (NIC) and the Network Innovation Allowance (NIA).

Currently the electricity NIC makes £90 million available annually for projects. This

comprises £30 million from the transmission price control (RIIO T1) and £60 million

from the electricity distribution (RIIO ED1) price control. However, the contribution

from RIIO ED1 was only set for the first two years (ie 2015 and 2016).

To determine the RIIO ED1 funding for its remaining six years (2017-2023) we’ve

evaluated the Low Carbon Network Fund (LCNF). The LCNF was introduced in the

previous electricity distribution price control to encourage the companies to be more

innovative in delivering low carbon connections and other network services. In

addition, we’ve also carried out a post implementation review of the governance

arrangements for the NIC and NIA to ensure these operate effectively.

This consultation sets out our findings from the above reviews. We are now seeking

stakeholders’ views on our assessment and our proposals, which cover:

1. Delivering greater value for money to consumers from innovation

2. Funding available in the electricity NIC for the remainder of RIIO ED1

3. Enabling third party access to the NIC

4. Operational improvements to the NIC and NIA schemes

Delivering value for money

We think there is reasonable evidence that the price control innovation schemes are

providing value for money and helping to create a more innovative culture in network

companies. An independent evaluation of the LCNF scheme estimates net benefits of

between £800 million and £1.2 billion when projects are rolled out by the trialling

companies. The potential net benefits could be up to a six-fold increase when a GB-

wide rollout is factored in. Moreover, the evaluation remains positive even when

tested using more cautious assumptions such as a lower level of benefits attributable

to the scheme and a lower proportion of cost savings passed on to consumers.

Nonetheless, we think there are several opportunities to increase the value for


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money for consumers from the schemes. We are proposing:

1. To introduce a licence requirement for the network companies to take a more

strategic view and to work together to develop an industry innovation strategy.

We think a strategy would help focus innovation activities on key energy

challenges, and ensure learning is shared more widely and help avoid duplication.

2. To remove the Successful Delivery Reward (SDR) arrangements from the NIC.

This would mean the network companies make a non-refundable 10%

contribution towards the project costs. Under the SDR the companies typically

get back this amount upon successful completion of the project. We think it is

appropriate to remove the SDR as it increases the stake companies have in a

project and will encourage them to bring forward better projects.

3. To remove the provision for companies and other parties to recover bid

preparation costs (BPC) from the NIC fund. The current provision is an anomaly

compared to other research and development funding mechanisms. Removing

the BPC will mean that the full funding paid for by consumers is used on projects

and not the cost of developing submissions.

Funding available for 2017 to 2023

A total of £90 million has been available in the electricity NIC for the first two years

of the RIIO ED1 period. In recent years the companies have submitted bids for £60

million and we’ve awarded around £40 million annually. We do not think there is a

strong case for increasing the level of funding – this is unlikely to have much effect

because the funding available has significantly exceeded the value of project bids.

We’ve considered the case for maintaining the current level of funding i.e. £90

million versus reducing the level of funding slightly to £70 million. On balance, we

think that reducing the level of funding slightly to £70 million will help increase the

value of the scheme from consumers’ perspective. We expect increasing the

competition for funds will help to drive up the quality of the project bids. In

combination with other changes, such as encouraging third party access, we’d expect

to see more collaborative approaches which will help leverage the benefits from the

consumer funded innovation schemes.

Increasing third party involvement

Under current legislation third parties can only bid for projects if partnering with a

network company. Although third parties cannot bid independently, there is

significant third party involvement in the NIC. In addition, the network companies

can only spend 25% of its NIA allowances internally (i.e. 75% must be delivered by

third parties).

However, there could be issues if the network companies are unwilling to bring

forward ideas that could be very disruptive for the sector or undermine current

business models.

We think the benefits of the price control innovation schemes could be further

enhanced by more involvement of third parties. Greater third party participation will

help increase the pool of technology and ideas. Therefore, we are consulting on the

following proposal to help increase the involvement of third parties in the NIC.


7

Requirement on network companies to issue a call annually for ideas from third

parties and to respond to these publicly from 2017. We think this option would

help increase transparency and promote engagement with third parties. We note

two companies have previously engaged with third parties by using this approach

with successful outcomes for some bids.

Allowing direct access to the NIC for third parties would require legislative changes.

Direct access for third parties goes beyond the original policy rationale for

introducing innovation schemes which was to address disincentives in the price

control framework for network companies to innovate. If it were introduced we

recognise there could be some practical issues with managing the process and

governance of projects, if these involve unregulated entities. Although most

stakeholders didn’t support direct access when we previously considered this issue in

2011, we’d be interested to hear if views have changed.

Operational improvements

The NIC and NIA governance documents set out the rules, processes and

administration of the schemes for gas and electricity. Having reviewed the schemes’

implementation to date we are proposing several changes to the governance

arrangements. Some proposals are to reduce the burden on network companies and

Ofgem. For example, we are proposing to make it less onerous for companies to

change NIC projects after funding has been awarded. This will give companies more

flexibility in running their projects without us having to approve minor changes. We

are also proposing some changes to ensure the effectiveness of the schemes. For

example, we have set out some proposals to improve our visibility and

understanding of projects that are being funded through the NIA.

Next steps

We are convening an Innovation Working Group on 11 January 2017, at our London

offices, so that we can discuss our proposals. We also intend to cover the proposed

drafting changes to the governance documents. For further information on this event

please email [email protected].

We welcome responses to the issues and specific questions set out in this document

by 6 February 2017. Responses should be sent, preferably by email, to

[email protected] or in writing to:

Neil Copeland

Ofgem

Third Floor

107 West Regent Street

Glasgow

G2 2BA

If you wish to have your response remain confidential, please clearly mark the

document to that effect. Unless marked confidential, all responses will be published

on our website.




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1. Background and scope of our review

Chapter Summary

This chapter provides some background on the provision of innovation funding in the

RIIO price control framework and explains the scope of our review.

Introduction

1.1. In regulating energy networks, we promote innovation which brings benefits

and value for money for consumers. In December 2015 we consulted stakeholders

for views on the governance of some of the RIIO innovation funding mechanisms

for electricity and gas, and the level of funding that should be available in the

electricity Network Innovation Competition (NIC) for the period 2017 - 2023. A

summary of the consultation responses is given in Appendix 1.

1.2. We have considered responses to that consultation, and also the findings

from an independent evaluation we commissioned of the Low Carbon Network Fund

(LCNF), a previous innovation mechanism in developing our proposals. This

consultation is seeking your views on our proposals.

The need for innovation by network companies

1.3. The energy system is undergoing rapid and significant change. Electricity is

increasingly generated by small intermittent generators connected to the

distribution network. On the gas network ‘renewable’ sources of gas are being

injected into the network. Network-related costs could increase significantly from

the current level. We think it is in consumers’ interests that the network companies

respond creatively to the challenges posed by these changes. New approaches

could deliver more efficient and timely services needed by network customers and

lessen the cost impact on consumers. This might be achieved, for example, by

developing and adopting new technology, different operational practices and novel

commercial arrangements.

1.4. Monopoly network companies generally undertake less innovation than is

optimal. There are a number of reasons for this lack of innovation, most notably

because savings resulting from innovations are shared with consumers and lead to

lower cost allowances, for network companies, in future price controls.

1.5. The need for innovation is critical when the energy system is changing as

much as it is now, with new sources of generation and types of load connecting to

the network. The challenge to networks is to facilitate more customers’

requirements for using the network with the assets they have rather than making

more capital expenditure where there may be other methods of providing capacity.


9

We recognised these issues when we undertook a review of the price control

framework we use to regulate the network companies.2

Innovation within the RIIO framework

1.6. Encouraging the network companies to innovate in providing network

services and outputs is a key element of the RIIO model. Several features of the

price control framework are intended to bring about more innovation by network

companies. These include:

Eight year price controls which mean network companies can retain the

benefits of innovation for longer before their allowances are re-set at the

next price control review; and

The ‘totex’ approach which equalises the incentives between capital and

operational expenditure meaning there are not undue incentives towards

investing in capital expenditure.

1.7. In addition to the generic features of the price control framework we also

introduced specific innovation funding mechanisms. These mechanisms are

intended to act as an initial catalyst to bring about culture change within the

businesses that run the gas and electricity networks in GB. Eventually we expect

the features in the price control framework to be enough to incentivise innovation

by licensees.

1.8. The table below summarises the NIC and NIA schemes.

The Network Innovation

Competition (NIC)

The Network Innovation

Allowance (NIA)

Purpose of

scheme

To fund large flagship

development and demonstration

projects.

To fund smaller research,

development and demonstration

projects.

How

funding is

awarded

Companies submit bids and

compete for project funding

Allowance set at start of price

control based on quality of

company’s own innovation strategy

Funding

available

each year

£90 million for electricity

networks

£20 million for gas networks

£61 million

1.9. In addition to the schemes above there is also the Innovation Rollout

Mechanism (IRM). This is intended to accelerate the rollout of proven innovations

into business as usual where the company is not going to benefit from the rollout

within the price control period. The IRM is not within the scope of our review or this

consultation.

2 https://www.ofgem.gov.uk/network-regulation-riio-model/background-rpi-x20-review

https://www.ofgem.gov.uk/network-regulation-riio-model/background-rpi-x20-review


10

1.10. The £90 million electricity NIC is comprised of £30 million from the

transmission (RIIO T1) price control and £60 million from the electricity distribution

(RIIO ED1) price control.3 However, the £60m contribution from the RIIO ED1

control was only set for the first two years of the regulatory period (ie 2015 and

2016).

1.11. The amount available annually under the gas NIC is £20 million. This has

been set until the end of the RIIO T1 and RIIO GD1 price control periods.

Scope of our innovation review and this consultation

1.12. The funding commitment from the RIIO ED1 price control to the electricity

NIC was set for only the first two years. As part of our RIIO ED1 strategy we said

we’d evaluate the Low Carbon Network Fund (LCNF) – an innovation mechanism

introduced in the previous electricity distribution price control - to inform the level

of funding for the remainder of RIIO ED1. We now need to determine the level of

funding of the electricity NIC for the remainder of RIIO ED1 (2017 to 2023).

1.13. Separately we committed to reviewing the governance documents for the

NIC and NIA after they had been in operation for two years. These governance

considerations apply to both the electricity and gas NICs and NIAs.

1.14. The scope for the innovation review covered by this consultation is:

an evaluation of the LCNF and whether consumers are getting value for

money from the scheme

a decision on the funding to make available for the electricity NIC for the

remainder of the RIIO ED1 price control, and

changes to the governance of the NIC and NIA across all of the RIIO price

controls to ensure the schemes are running effectively.

3 There is no fixed split in terms of how it is awarded between transmission and distribution

related projects in the competition.


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2. Evaluation of the Low Carbon Network

Fund

Chapter Summary

This chapter sets out the key findings and recommendations of an independent

evaluation of the Low Carbon Network Fund (LCNF) carried out by Poyry and Ricardo

Energy.

Introduction

2.1. This chapter sets out:

Background on the LCNF

Our rationale for commissioning an independent review of the LCNF

Scope of the independent evaluation

A summary of the consultants’ findings and recommendations

Background to the LCNF

2.2. The LCNF was introduced as part of last electricity distribution price control

DPCR5 (2010 to 2015) to encourage the distribution network owners (DNOs) to be

proactive in facilitating the transition to a low carbon economy. A total of £500

million was available for innovation projects on electricity distribution networks. It

was anticipated projects would include trials of new technology, systems,

commercial and network operating arrangements. To be eligible, projects had to

have the potential to deliver financial and carbon benefits to existing and/or future

network customers.

2.3. The LCNF provided two tiers of funding for projects:

Tier One – an allowance to fund smaller research and development projects,

which had a maximum duration of three years. The maximum value of

projects the DNOs could register in this period was £80 million. Under Tier

One 42 projects totalling approximately £30 million were registered.

Tier Two – involving an annual competition with £64 million available each

year to fund larger flagship development and demonstration projects. In

total £245 million was awarded to 23 projects.


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Why we’ve commissioned an evaluation of the LCNF

2.1. In our strategy4 decision for the RIIO ED1 price control review we committed

to making available £60 million annually for the electricity NIC from RIIO ED1 in the

first two years. This was in addition to the £30 million available each year under the

RIIO T1 price control. We said that we would consult on the amount to be available

under the NIC for the remainder of the RIIO ED1 price control period and that this

would be decided following an evaluation of the NIC predecessor - the LCNF.

2.2. Given the materiality of the funding paid for by consumers under the NIC,

we considered it was important to commission an independent review of the

scheme. The purpose of the evaluation was to look at the impact the scheme has

had on companies’ culture towards innovation activities, as well as whether the

projects funded under the scheme will deliver value for money for consumers.

Scope of the independent evaluation

2.1. We commissioned consultants, Poyry and Ricardo Energy to carry out an

independent evaluation of the LCNF. The aim of the evaluation is to understand the

extent to which the LCNF has helped to develop innovation in the industry, whether

the projects have helped to accelerate the development of a low carbon energy

sector and delivered value for money.

2.2. In addition, we asked the consultants to identify if there were any gaps, and

whether we should make any changes to the governance arrangements of the NIC

and NIA – successors to the LCNF.

Key findings from evaluation

2.3. The consultants carried out a qualitative and quantitative assessment of the

LCNF. The qualitative evaluation looked at whether there had been any cultural

change by the DNOs to become more innovative, whether projects were suitable for

and being integrated into the business for deployment, and what third-

party/stakeholder engagement had been undertaken by the DNOs. In their

quantitative evaluation, the consultants estimated the financial and carbon benefits

delivered by LCNF projects – both now and in the future – to consider whether this

justifies the financial commitment. A copy of the consultants’ report is available on

our website alongside this consultation document.

4 https://www.ofgem.gov.uk/publications-and-updates/strategy-decision-riio-ed1-overview

https://www.ofgem.gov.uk/publications-and-updates/strategy-decision-riio-ed1-overview


13

Qualitative findings

2.4. The consultants’ qualitative assessment was based on questionnaire

responses from a broad range of stakeholders about their experience of the LCNF

projects.5 The main qualitative findings are:

The LCNF has succeeded in encouraging the DNOs to innovate and has

helped moved the level of innovation within DNOs from a ‘low’ base to a

‘moderate’ level.6 However, while the DNOs are including innovation as

core business, this is still a work in progress.

All LCNF projects have made some technical and/or commercial

contribution to the acceleration of the development of the low carbon

energy sector. Projects associated with connecting distributed generation

without the need for network reinforcement have a high potential value

and are most likely to be readily incorporated into the current business.

This benefits generators by saving time and money; and energy

consumers through lower network charges.

Knowledge dissemination was good across the Tier 2 projects that have

been completed. However, dissemination has been weaker across Tier 1

projects. The consultants also find that there is little evidence of

knowledge coordination across the DNOs to combine and use learning

from projects, and to inform the direction of future projects.

DNOs are integrating LCNF innovation initiatives into the business.

However, the assessment found that only 37% of initiatives trialled

under the LCNF were immediately applicable to business as usual.

Another 41% would be applicable if circumstances changed – such as

increased take up of electric vehicles or a wider use of heat pumps.

Finally, 22% of initiatives would require further development before

being used within the day to day businesses of network companies.

A wide range of partners, stakeholders and customers have been

involved with the LCNF projects and there is has been effective

collaboration and/or engagement between DNOs and third parties as a

result.

Quantitative findings

2.5. The quantitative assessment aims to evaluate whether the benefits of the

LCNF justify the costs of the scheme. The consultants’ estimates are based on data

and forecasts provided by the DNOs for individual projects. This covers

5 Stakeholders included DNOs, project partners, industry participants, and selected academics. 6 Low level: where companies have little or no interest in innovation and no overall programme. Moderate level: where companies have some interest in innovation and a small number of projects but no overall programme. See Annex F of the report for more information

on these definitions.


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administration and project costs, current benefits from projects, as well as future

financial and CO2 benefits that accrue between 2016 and 2031.7

2.6. The DNOs identified a variety of financial benefits from the LCNF projects.

These are: reduced connection costs, reduced network management costs, reduced

electricity losses, security of supply improvements, provision of ancillary services

and demand-side response, deferral of network reinforcement, and improved asset

management and network reliability.

2.7. The estimated benefits of the LCNF include all current and future benefits

associated with each of the LCNF projects, except for the reduction in carbon

emissions. These are estimated separately.

2.8. Given the uncertainty associated with measuring the potential benefits of

innovation, the consultants monetised the potential benefits only where these could

be verified as credible and justified.

2.9. The consultants calculate the benefits of the LCNF as the sum of all benefits

from each of the LCNF projects. This is first estimated on the basis that the

innovation initiative is limited to the trialling DNO’s own network, ie not rolled out

more widely. The discounted net benefit of the LCNF – including current as well as

future benefits – ranges between £800 million to £1.2 billion.8

2.10. Allowing for benefits to accrue to other DNOs in addition to the DNO that

trialled the project – through knowledge dissemination – the estimate of the GB-

scaled discounted net benefit ranges between £4.8 billion and £8.1 billion.9

2.11. In this consultation we’ve presented the discounted estimate of the future

potential benefit. The discounted estimate also takes into account what might

reasonably be expected to have happened in the absence of the LCNF ie a

counterfactual level of innovation activity. For the counterfactual it’s been assumed

that 20% of the gross estimated benefits would have occurred in the absence of the

LCNF eg in response to Ofgem/Government pressure to accelerate distributed

generation connections.10

2.12. In the evaluation report the consultants present the gross benefit estimates

which are not discounted nor are they adjusted for the counterfactual level of

innovation. We think using the discounted values that are adjusted for the

counterfactual (as described in paragraph 2.11) is a better indication of the

expected value of the future potential benefits from the LCNF projects.

7 The end of the RIIO ED2 price control period. 8 The value of future net benefits was discounted using a discount rate of 3.5% - this is the recommended HM Treasury rate for discounting and is set out in the HM Treasury Green Book. 9 Where one innovation precluded the use of another initiative then the benefit of rolling out a single method was included within the GB-scaled calculation. 10 Additional sensitivity analysis around the 20% level was carried out when estimating the net

benefits.


15

2.13. The figure below shows the cost, the current benefits and potential future

benefits of the LCNF. While current benefits have not exceeded the costs of the

scheme, the potential future benefits significantly exceed the cost to consumers of

the scheme.

2.14. The above estimates indicate that a GB-wide adoption by DNOs of the LCNF

innovation initiatives could potentially deliver significant savings. The DNOs and

those using the network will benefit from innovation because it lessens the cost of

connecting to and operating the electricity distribution networks.

2.15. The consultants have estimated that approximately 40% of the savings

realised through the LCNF will initially flow to network companies, and eventually

flow to consumers as a consequence of the price control framework. Later in this

section we explore what happens if we adopt an assumption that a smaller

proportion of the benefits flow to consumers.

2.16. The LCNF was intended to encourage DNOs to play their part in facilitating

the transition to a low carbon economy. The evaluation suggests the LCNF could

also deliver significant carbon benefits, in addition to the financial benefits. The

consultants estimate reductions in CO2 emissions of between 107 million and 215

million tonnes if initiatives are adopted GB-wide, equating to between £600m and

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Costs of scheme Current financial benefits

up to 2016

Future financial benefit if

only trialling DNO rolls out

Future financial benefit if

rolled out across GB

Costs and estimated net benefits of the Low Carbon Network Fund£ millions

£4.8bn to £8.1bn

£800m to £1.2bn

-£300m -£204m


16

£1.2bn.11 As a point of comparison, total CO2 emissions from UK energy supply

were provisionally estimated to be 136 million tonnes in 2015.12

Uncertainty around the estimated benefits

2.17. The consultants highlight that there is inherent uncertainty in the estimated

benefits of the LCNF innovation projects, as these are testing innovative concepts

and novel ideas which are uncertain.

2.18. The estimates are based on the DNOs’ forecasts of benefits. While these

have been sense checked by the consultants they haven’t been evaluated in detail.

Moreover, the total benefits are estimated across the entire supply chain and not all

of these might accrue to consumers, ie some innovations might just increase profits

for generators or DNOs.

Sensitivity analysis

2.19. We note the consultants’ estimated financial benefits have been calculated

for the whole system rather than just to consumers. To test whether the potential

benefits of the LCNF justify the costs from the perspective of consumers, we’ve

applied some more conservative assumptions to estimate of the potential future

consumer benefit. For example, we’ve assumed that 50% of the benefits would

have arisen anyway even in the absence of the LCNF rather than the 20% assumed

by the consultants. Our other assumptions are listed in the table below.

Issue Conservative assumptions

Proportion of benefits that would have

arisen without our intervention.

50%

Proportion of benefits that DNOs would

pass to consumers in ED1

40% (based on the proportion of

savings shared with consumers under

the price control)

Proportion of benefits that we would

identify in setting RIIO ED2.

50%

Proportion of benefits accruing to other

parties (eg generators) that would be

passed through to consumers.

50%

Proportion of projects rolled out to other

DNOs of those identified as being suitable

for GB-wide roll out.

50%

11 Assuming a CO2 price of £5.91/tCO2. 12 Taken from Provisional estimates of UK Greenhouse Gas emissions for 2015, including quarterly emissions for 4th quarter 2015 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/511684/2016

0331_2015_Provisional_Emissions_Statistics.pdf

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/511684/20160331_2015_Provisional_Emissions_Statistics.pdf

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/511684/20160331_2015_Provisional_Emissions_Statistics.pdf


17

2.20. When these more conservative assumptions are applied, the discounted

financial benefits under this scenario are around £1 billion (roughly three times the

cost of the schemes), excluding any CO2 benefits. This is still a significant net

positive outcome for consumers from the LCNF. This equates to a net benefit to

consumers of around £700m. At worst, say if there were no roll out GB-wide,

consumers would still roughly break even. However, we think little or no roll out is

unlikely to be the case.

Recommendations from the evaluation

2.21. On the back of evaluating the LCNF, the consultants also made some

recommendations to improve the effectiveness of the NIC and NIA and increase the

value for money delivered by these schemes. The table below lists the consultants’

recommendations and further information on how we are responding to these.

Recommendation Our Response

1. Ofgem should continue to fund DNO

innovation to ensure the culture of

innovation continues to develop.

Consideration should be given as to how

support for DNO innovation can best

accommodate the future requirements of

the whole energy system.

In chapter four of this document we set

out our proposals regarding the future

contribution from the electricity

distribution price control to the

electricity NIC.

2. The DNOs should jointly develop and

publish an ‘innovation roadmap’. This

should be developed in conjunction with

EPSRC, DBEI, Innovate UK and other

relevant industry initiatives to ensure

funded innovation is optimised to deliver

maximum benefit for customers and tax

payers.

In chapter three we set out our proposal

to require all network companies to

work together to develop an industry

innovation strategy for the electricity

and gas networks/entire energy system.

3. There should be greater focus on the

sharing of project knowledge and

learning – particularly across and

between the DNOs – in order to

maximise the benefits and value of LCNF

initiatives and innovation.

Learning dissemination is a key aim of

the NIC. The scheme governance

documents set out the minimum

requirements we expect companies to

undertake.

In chapter five we set out our proposals

to require network companies to share

the data they gather when implementing

the NIC and NIA projects.

4. Ofgem should capture information as

part of its ongoing price control

monitoring so that it can have more

robust estimates for any future

evaluations.

In chapter five we are proposing to

require network companies to report on:

Plans for rolling out novel

methods in to business as usual;

The costs of rolling out proven

innovations, and

The reasons why they do not

plan to make use of a new

method that has been developed.

5. Reporting requirements associated

with any future innovation funding

should be reviewed to facilitate the

future assessment of quantitative


18

Recommendation Our Response

benefits.

6. Introduce an ongoing requirement for

DNOs to report progress associated with

business-as-usual implementation of

LCNF project outcomes and learnings.

7. More focus should be placed on the

learning which results from unsuccessful

projects, or parts of projects.

Part of the reason we provide innovation

funding, is a recognition that by their

nature the relevant activities are risky.

Where projects fail because of an

incorrect hypothesis, network companies

should share this learning just as they

should when a hypothesis has been

proven correct.

8. LCNF participants should be required

to co-ordinate with relevant Government

departments, and other institutions, to

explore opportunities to share and

exchange project learnings, and

experience, with other sectors and with

other countries and jurisdictions.

Through the requirement to develop an

innovation strategy we will require

network companies to engage with

Government and other interested

bodies.

With regard to sharing learning

internationally, we welcome this,

however, GB customers have funded the

development of knowledge and

intellectual property therefore they

should benefit from any use

internationally.


19

3. Proposals for delivering greater value

for money

Chapter Summary

In this chapter we set out our proposals for governance changes to the gas and

electricity NIC that are aimed to deliver greater value for money to existing and

future consumers from the innovation they pay for.

Question box

Question 1: What are your views on our proposals to introduce a

requirement for the network companies to jointly develop an industry-wide

innovation strategy?

If you agree, should companies retain their own strategies, and in

addition should there be a single system strategy, or one for gas and

another for electricity?

How often should the strategy be updated?

Question 2: What are your views on our proposals to help facilitate

increased involvement of third parties in the NIC via the network

companies?

Question 3: What are you views on providing direct access for third parties

to the NIC?

Question 4: What are your views on our proposals to remove the Successful

Delivery Reward and the provision to recover Bid Preparation Costs?

Introduction

3.1. The evaluation of the LCNF in chapter 2 shows that there are significant

benefits arising from network innovation initiatives and that consumers are

expected to receive significant value for money. The evaluation provides a

reasonable justification for including the NIC and NIA schemes as part of the RIIO

price controls. However, we believe it is in consumers’ interests that we capitalise

on the opportunities to make the schemes more effective and potentially further

increase the pay back for consumers.

3.2. We are consulting on several proposals to increase the value for money that

consumers will receive from the NIC. These build on the recommendations in the

consultants’ evaluation, as well as stakeholders’ responses to our initial December

2015 consultation on the innovation review.


20

3.3. In this chapter we set out options that we propose to apply to both the gas

and electricity NIC. These are:

A new requirement on the network companies to take a more strategic

view of innovation and jointly develop an industry innovation strategy;

Options to facilitate increased third party involvement and potential

direct access to the NICs;

Removing the successful delivery reward; and,

Removing the provision to recover bid preparation costs from the NIC.

Industry to develop a strategy for innovation

3.4. A key recommendation of the evaluation report is that the industry should

develop a strategy for innovation across GB. The consultants highlight that there

currently isn’t a clear strategy or approach to innovation across the industry. We

agree it is important for the industry to develop a joined up approach – to ensure

innovation is focussed on priority areas offering significant potential benefit,

learning is shared, and any unnecessary duplication is avoided.

Requirement on network companies to develop a network innovation strategy

3.5. We propose requiring the RIIO network companies to develop either one or

two innovation strategies - depending on whether a strategy is developed for

network innovation across the entire energy system or whether separate strategies

are developed in tandem for the gas networks and electricity networks. We propose

incorporating this requirement into the standard licence conditions of the network

companies. Our proposed aims, approach and output of an innovation strategy are

outlined in the following table.

Aims Identify priority areas with scope/potential for innovation and have a

co-ordinated approach to tackle these areas Have a joined up approach to innovation across GB

Demonstrate that innovation builds on previous projects and does not

unnecessarily duplicate them

Learn from international innovation projects

Approach Consider the innovation learning to date and how the strategy builds

on the learning so far Identify innovation projects internationally that can inform the

strategy

Consult with relevant stakeholders on a draft innovation strategy

Output Publish a report every two years setting out: Innovation themes and challenges that would benefit most from

innovative ideas

Approach to co-ordinating innovation projects amongst network

companies and other parties


21

3.6. We are interested in stakeholders’ views on whether it would be better to

develop a system-wide network innovation strategy or to have separate gas and

electricity network strategies. We also are seeking stakeholders’ views on whether

there are other issues the strategy should cover.

3.7. We think the network companies should cooperate to jointly develop a

strategy. In addition, we propose requiring network companies to consult with

relevant bodies with an expertise in energy and energy innovation, eg the

Engineering and Physical Sciences Research Council (EPSRC), the Department of

Business Energy and Industrial Strategy (BEIS), and Innovate UK. We would like to

know whether there are other organisations stakeholders think network companies

should engage with.

3.8. Strategies are generally a plan of action for the mid to long term. However,

given the period of rapid change in energy sector the focus of network innovation

may have a shorter time horizon than this. Therefore, we propose that network

companies review and update an industry strategy every two years.

Interaction with companies’ individual innovation strategies

3.9. For the current RIIO price controls we required the network companies to

develop and submit individual innovation strategies. These company-specific

innovation strategies explain the high level problems and challenges the company

expects to face. They also explain how they intend to focus their innovation

activities during the price control period including a list of high level deliverables, eg

delivering learning in particular areas. These were used to assess the level of NIA

companies should receive.

3.10. We placed a requirement on the DNOs to maintain their innovation strategies

so that they have an up to date strategy governing their use of innovation funding.

We recognise that the challenges faced across the different sectors and in the

licence areas in GB might vary in scale and likelihood. We are interested in

stakeholders’ views on whether the companies should continue to be required to

have their own strategies in addition to an industry wide strategy.

Increasing third party involvement

3.11. Third parties cannot bid directly for NIC funding due to a restriction under

the existing legislation. Instead, third parties (non-network companies) must

partner with a network company to be able to bid for projects. This means that

they must find a network company willing to work with them to develop and submit

a project.

3.12. Some projects have come forward under the competitions that have been led

by third parties. However, third parties have said that it is difficult to do this

through the competition.


22

3.13. Despite the lack of direct access there is significant third party involvement

in the NIC. Also, under the NIA (currently ~£60m per year) the network companies

can only spend 25% of the allowances internally, ie 75% of the funding must be

spent with third parties.

3.14. Third party involvement in the NIC is valuable as non-network companies

bring different skills, new technologies and ideas, helping to increase the variety

and quality of potential bids. Third parties are also more likely to propose radical

innovations as they face less contextual constraints, eg more likely than DNOs to

develop options that challenge the network companies’ current business models.

We think increasing third party involvement in the NIC is desirable from a

consumer perspective as it could improve the outcome of the NIC overall.

Require network companies to issue a call for ideas every year

3.15. For the 2016 NIC, Western Power Distribution issued a call for ideas from

third parties. It subsequently submitted two of the projects that came forward.

National Grid has also run its own call for third party innovation proposals.

3.16. We have two proposals to increase the involvement of third parties in the

NIC which build on the approach taken by some companies already. These are:

Require network companies to issue a call for ideas annually from third

parties and to respond to these publicly. We expect the increased

transparency and profile of the issue to improve the calibre of projects

that are brought forward and promote engagement with third-parties.

Raise the number of projects that network companies can put forward as

full submissions from two to four, where additional projects are led by

third parties and result from the call for ideas. This would allow network

companies to continue to bring forward their own projects alongside third

party bid proposals.

3.17. We are interested in stakeholders’ views on whether the companies should

hold a single collective call or whether they should run their own individual calls. In

any case, we propose companies must respond to all proposals publicly and to

explain why any are not progressed.

3.18. If this proposal is taken forward we anticipate the network companies

running the first call for ideas in late 2017 with projects being submitted to the NIC

initial screening stage in 2018.


23

Potential direct access for third parties to the NIC

3.19. When we were developing the NIC, we consulted in 2011 on allowing third

parties direct access to the NIC. 13 At that time there was very limited appetite for

this. However, in the intervening period, some external commentators, eg the

Energy & Climate Change Committee, and other stakeholders including technology

developers, have suggested that third parties should be allowed direct access to the

NIC.

3.20. The rationale for innovation funding mechanisms such as the NIC was to

address the inherent disincentives in the price control framework to the network

companies to innovate. Allowing third party direct access to the consumer-funded

innovation mechanism would clearly go beyond this original intention. We are not

sure whether government would be more suited to engaging third parties on

innovation initiatives.

3.21. As noted above, existing legislation prohibits third parties participating in the

NIC without a network company partner. While changes to primary legislation could

be made to allow direct access for third parties – we currently do not have

sufficient evidence to show that a change in the current arrangements is either

desirable to third parties or could reasonably be expected to enhance the benefits

of the NIC for consumers. Some potential issues include:

How to get innovation into business as usual without a network company

participant in a project.

It is also not clear that non-network companies would be willing to

accept some form of innovation licence.

3.22. We are interested in hearing whether stakeholders’ views on allowing direct

access for third parties have changed since we last consulted on this issue in 2011.

We also welcome stakeholders’ views on whether they think other bodies, eg

Innovate UK or the Government are more suited to providing and administering

innovation funding to third parties rather than Ofgem.

3.23. We will consider responses to this consultation and then decide whether to

support legislative change that would be required to enable direct access.

Other things we are doing to support innovators

3.24. Later this month, Ofgem will launch a new Innovation Link service to

promote beneficial innovation in the energy sector and inform how we regulate in

the future. 14 It will be a point of contact for energy innovators to bring new ideas to

13 https://www.ofgem.gov.uk/ofgem-publications/56942/ope-letter-consultation-non-network-company-

access-innovation-stimulus.pdf 14 Parties with an innovative or significantly different business proposition for the energy

https://www.ofgem.gov.uk/ofgem-publications/56942/open-letter-consultation-non-network-company-access-innovation-stimulus.pdf

https://www.ofgem.gov.uk/ofgem-publications/56942/open-letter-consultation-non-network-company-access-innovation-stimulus.pdf


24

receive fast, frank feedback on the regulatory implications. The Link will also bring

forward proposals in due course on providing a ‘regulatory sandbox’ for innovative

approaches and products to be trialled within the existing regulatory framework.

Removal of successful delivery reward

3.25. Under the current NIC arrangements, companies make a notional 10%

contribution to the cost of projects. The companies can apply to have this

contribution returned through a successful delivery reward (SDR) when the project

is completed. The SDR was originally intended to incentivise efficient delivery and

good project management by network companies.

3.26. We are proposing to remove the SDR for any future projects funded through

the gas and electricity NIC, ie projects awarded funding from 2017. We are also

proposing to make the companies’ 10% contribution to project costs non-

refundable.

3.27. We think it is a good time to transition more responsibility to the companies

for successful project management as the independent evaluation has found that

network companies are developing a stronger innovation culture.

3.28. We also think making the 10% contribution non-refundable is justified by the

findings of the LCNF evaluation report that show a significant proportion of the

benefits from innovation projects flows to network companies. The companies are

benefitting and therefore should make a real contribution to the costs of

implementing innovation projects. This will increase the stake companies have in a

project and will encourage them to bring forward better projects, which will

ultimately benefit consumers.

3.29. Overall we consider the proposal to remove the SDR and make a 10%

contribution to project costs non-refundable would increase the value for money

that consumers get from the NIC.

Removal of provision to recover bid preparation costs

3.30. All parties participating in the NIC can recover the cost of developing bid

submissions from customers. Network companies covered by a RIIO price control

recover these costs through the NIA. Other network companies such as offshore

transmission owners can request these costs as part of their submissions. For other

parties these funds are provided from the annual NIC pot. Parties can currently

sector can contact the Link at [email protected]



25

recover either £175k or 5% of the funding requested that year, whichever is

smaller.

3.31. We propose to remove the provision that allows parties to recover bid

preparation costs from the NIC or the NIA from 2018/19.

3.32. The recovery of these costs in the NIC is an anomaly compared to other

funding mechanisms that the network companies can access for research and

development funds (eg, Innovate UK, Horizon 2020, Research Council funding).

Removing this funding would bring the NIC into line with other funding mechanisms

that network companies can use. The concept of “expenses follow success” is well

proven in tendering activities across multiple industries not just research and

development grant bids.

3.33. Our proposal to remove the provision to recover bid preparation costs means

that the NIC pot would be used in its entirety to fund actual projects and not the

cost of developing submissions. Similar to our proposal to remove the SDR, we

think this will help deliver value for money to consumers for the innovation

activities they pay for.

Combined potential impact of our proposals

3.34. We expect consumers will benefit overall as a result of the proposals set out

in this chapter. An increase in the involvement of third parties and a coordinated

approach to innovation across the network companies will provide a fillip to

proposals that are brought forward in future. At the same time, we recognise there

is a risk that a 10% non-refundable contribution to project costs and removing the

recovery of bid preparation costs, might result in some network companies making

fewer bids. However, we think the net impact will result in better quality and more

strategically targeted bids – which we expect partly as a result of companies

putting more of their own money at risk. Overall this should help ensure consumers

get good value for money from the NIC going forward.

Timing of proposed changes

3.35. The table below summarises the timeframes in which we anticipate the

proposals outlined in this chapter would take effect. However, this is subject to

consultation responses.

Proposal When it would come into

effect

Extra notes

Industry

innovation

strategy

New Standard Licence

Condition in 2017.

Network companies would work

to develop a strategy over 2017.

Call for third

party led

projects

This would have effect when

the new version of the

governance document is

introduced in 2017.

Network companies to hold a call

for ideas in 2017. Any successful

third party led projects will be

submitted to the NIC in 2018.


26

Proposal When it would come into

effect

Extra notes

Removing the

successful

delivery reward

Projects awarded funding

from 2017 would not be

eligible to seek a successful

delivery reward.

Removing the

provision to

recover bid

preparation

costs (BPC)

Network companies would

be able to recover bid costs

in 2017/18 but they

wouldn’t recover these from

2018/19.


27

4. Proposal for future funding level of the

electricity NIC

Chapter Summary

This chapter outlines our considerations for setting the level of funding available

under the electricity NIC, and our proposal to reduce the contribution from the

electricity distribution price control from £60 million to £40 million per year over

2017 – 2023.

Question box

Question 1: What are your views on the rationale for reducing the level of

electricity NIC funding pot?

Question 2: What are your views on the proposed funding level of the

electricity NIC?

Introduction

4.1. A total of £90 million has been available in the electricity NIC for the first two

years of the RIIO ED1 period. This comprises £30m from the RIIO T1 price control

and £60m from the RIIO ED1 price control. However, the funding commitment from

the RIIO ED1 price control to the electricity NIC was set for only the first two years.

4.2. This chapter sets out the relevant factors we have considered in proposing

the funding of the electricity NIC for the remainder of RIIO ED1 (2017 - 2023).

How much funding should we make available?

4.1. The independent evaluation of the LCNF and our sensitivity analysis provides

a strong case for maintaining funding in a significant form for the remainder of the

RIIO ED1 period. This is because we think that it is likely to continue to drive

beneficial innovations by the network companies that would not happen otherwise.

There are good signs that innovations are making their way in to, day to day use

within the network companies and delivering financial and carbon benefits. The

expected future consumer benefit of these initiatives is expected to comfortably

exceed the costs that consumers are currently paying. Therefore we think

maintaining the electricity NIC is justifiable because it offers value for money to

existing and future consumers.

4.2. Historically the LCNF competition and the NIC have tended to be

undersubscribed. For example, this year there is a pot of £90 million of which only

£54 million has been bid for. The graph below shows the level of funding that has

been available, requested and awarded in the LCNF and NIC.


28

4.3. Based on their evaluation of the LCNF, the consultants recommended that

we maintain NIC funding for now. Consultation responses to our December 2015

consultation also noted that while network companies had developed capability and

more focus on innovation, removing funding now might undo the positive change

that has taken place.

4.4. Notwithstanding the level of potential benefits from innovation estimated in

the evaluation of the LCNF, we do not think there is a strong case to increase the

funding pot from current levels as it would likely have little impact given historical

levels of take up. In addition, it’s always been the overall policy intention that the

price control mechanisms should eventually drive innovation without the need for

specific innovation funding. Increasing funding now would therefore be inconsistent

with our desire when creating RIIO, for the innovation schemes to be time-limited.

4.5. Accordingly we think the choice is between maintaining the current level of

funding at £90 million or reducing it slightly. Overall, we favour reducing the overall

funding pot from £90 million to £70 million. This is because:

A reduction in the pot is likely to help create healthy competition for

funds, particularly in combination with our proposals related to

increasing third parties involvement. We think that a £70 million pot

provides enough headroom for additional third-party led projects to be

submitted. The increased competition for funds that would result is likely

to lead to better quality projects being proposed and funded. In turn this

is likely to increase the benefits and value for money for consumers

overall.

We don’t think reducing the overall funding level to £70 million would

result to any detriment to customers. This is because we’ve seen

relatively significant levels of undersubscription in recent years.

0

20

40

60

80

100

120

140

160

2010 2011 2012 2013 2014 2015 2016

£ millions

Year

LCNF Awarded

LCNF Requested

LCNF Pot

NIC Awarded

NIC Requested

NIC Pot


29

We think reducing the level of funding is consistent with our policy intent

that the innovation funding is time-limited. Now that network companies

are developing an innovation culture it is a good time to transfer more

responsibility to them. Reducing the pot, and the amount consumers

have to pay, is consistent with policy intention to increase the stake

companies have in their individual projects (which would be achieved

through our proposal that companies make a non-returnable 10%

contribution to project costs). With more ‘skin in the game’ we think

incentives on companies for project success are better aligned with those

of consumers.

Contribution from RIIO ED1 over 2017 - 2023

4.6. Under the transmission price control, RIIO T1, we committed to a

contribution of £30 million to the electricity NIC for 2013 - 2021. Our proposal to

reduce the total electricity NIC pot from £90 million to £70 million would mean that

the contribution from RIIO ED1 would reduce from £60 million to £40 million for

the period 2017 - 2023.

4.7. Notwithstanding our proposal to set the electricity NIC pot at £70 million we

reserve the right to review the total amount available when we re-consider the

contribution in the next transmission price control review for RIIO T2.


30

5. Other proposals for governance

arrangements

Chapter Summary

In this chapter we set out our proposals for some additional changes to aspects of

the governance arrangements for the NIC and NIA.

Question box

Question 1: Do you agree with our proposals to clarify the circumstances we

do and do not expect change requests are submitted to us?

If you agree, do you think our proposed draft explanation of material

changes is clear?

If you think alternative drafting would achieve this more effectively

please provide this drafting.

Question 2: Do you have any feedback on our proposal to publish a plain

English guide to our default intellectual property (IP) requirements?

Question 3: Do you have any views on our proposals to improve the visibility

of the NIA projects? What are your suggestions for a proportionate way to

get assurance that the NIA is being used by network companies in an

appropriate way?

Question 4: Do you have any comments on any of our other proposals?

Introduction

5.1. The NIC and NIA governance documents set out the rules, processes and

administration of the NIC and NIA for both gas and electricity.

5.2. In chapter three we explained some of the more substantive changes we are

proposing to make to the NIC to drive greater value for money from the scheme for

consumers. The proposals set out in this chapter are lower level changes that aim

to improve the governance of the gas and electricity NIC and NIA. Amongst other

things, these should help reduce the administrative burden of running and

participating in the NIC and NIA, provide more assurance that innovation funding is

adding value, and provide useful information to inform our consideration of the

form of future innovation stimulus in the next round of price controls.

5.3. Unless stated otherwise, and subject to the outcome of this consultation, we

intend to implement our proposals in time for the 2017 competition. We will consult

before then end of the year on the governance and licence drafting to give effect to

our proposals.


31

Reducing the burden of processing change requests for NIC projects

5.4. Under the current governance rules, a company must request Ofgem to

approve material changes to the Project Direction (which, together with the

company’s full submission, specifies how a project will be managed and delivered),

if it has been awarded funding. However, the governance arrangements do not

define what is meant by a material change. Consequently this often leads to

network companies making requests for changes for relatively small changes, such

as using external contractors to deliver an aspect of a project that was originally

intended to be delivered by resource within the network companies’ workforces or

vice versa.

5.5. Therefore, we are proposing some changes to make it less onerous for

companies to change aspects of NIC projects after funding has been awarded. The

aim of these proposals is to give licensees more flexibility in running ongoing and

future projects without us having to approve changes. It also moves innovation

towards business as usual as licensees take more responsibility for progressing

innovation projects without oversight from Ofgem.

Proposal for ongoing NIC projects

5.6. To address this issue for ongoing projects we propose to define a material

change to a project in the governance rules as:

“A change which the licensee reasonably believes would have led the Expert

Panel to change its recommendation and the Authority to change its original

decision that the project should be funded – eg if the learning outcomes from

the project were to be different the Authority could reasonably have made a

different decision. For the avoidance of doubt – the following are examples of

changes that we do not consider to be material.

o Moving budget from one line to another to deliver the same output, or

o Delaying the project by less than 365 days.”

5.7. We welcome stakeholders’ feedback on the above proposed drafting or

alternatives to give best effect to the desired intent.

Proposal for future NIC projects

5.8. To circumvent this issue for new projects funded under the NIC in future we

are proposing a new approach. We propose that the network companies identify

specific project outputs and link individual elements of the funding request to these

outputs rather than the means of delivering a project. At the same time we propose

companies must record and justify any material changes but we will not require

companies to request permission from us to make them. In addition, we propose


32

that the network companies are also required to commission an external auditor

when the project is concluded to review whether the outputs have been delivered.

5.9. Where outputs have not been delivered we would claw back the funding

associated with the specific output. In recognition of the fact that we are funding

innovation projects and outputs will not always be delivered, we would not claw

back funds where the hypothesis being tested has turned out to be false. However,

in the event that delivery isn’t achieved we would consider whether to return

funding that had been awarded to companies. This situation might arise because a

project is (correctly) terminated at an intermediate stage due to a trial not being

successful meaning that the later outputs were not delivered. It could also arise due

to a failure in the network company’s management of the project.

Improving the interpretation of the default intellectual property arrangements

5.10. As part of the scheme governance arrangements we developed default

intellectual property (IP) arrangements because:

innovation projects could generate IP that could be of value to

customers, and

IP rights could act as a barrier to knowledge transfer across the industry.

5.11. The default IP arrangements are intended to address these challenges by

requiring all learning from innovation projects are shared with GB network

companies. In addition, under the NIC, royalty income generated via NIC projects

must be returned to customers.

5.12. The default IP arrangements are fairly flexible to allow arrangements to be

agreed on a project by project basis. The onus is on the network companies to

justify to the Authority that the agreements they enter into deliver value for money

to customers.

5.13. We’re aware that some stakeholders have concerns about different

interpretations of the default IP arrangements across the network companies.

5.14. We recognise that the current default IP arrangements can be applied in

different ways. To provide further clarity and assist network companies and other

stakeholders we intend to publish a plain English guide to the default IP

arrangements. We will publish this early next year. In the guide we will include

examples of the types of non-default arrangement we have approved in the past

and types we would not be willing to approve.


33

Removal of the contingency funding mechanism

5.15. As part of submitting bids to the NIC, network companies can reserve the

right to request additional funds during the implementation of a project. However,

they can only request these additional funds when cost overruns occur, and the

amount that can be requested is limited to five per cent of the original funding

request.

5.16. We propose to remove the contingency funding mechanism. This mechanism

has never been used by network companies and we think removing this provision is

consistent with other changes being proposed to get the networks to take on more

responsibility for innovation as being a business as usual activity.

Further assurance on project eligibility under NIA

5.17. Since the introduction of NIA, the network companies have registered more

than 400 projects. However, we’ve some concerns about the eligibility of a small

number of projects being registered under this scheme. In a few instances it’s not

clear to us why some activities aren’t being carried out by network companies as

part of their business as usual rather than as a NIA project. We plan to discuss this

with some of the network companies next year and where appropriate ensure that

funding is returned to consumers.

5.18. In the next section we propose some specific changes to improve the

visibility of the projects the network companies consider eligible for funding under

NIA.

Lower level changes we propose to the governance of NIC and NIA

5.19. In the following table we propose several other lower level changes to the

governance arrangements of the NIC and NIA. These include reducing the burden

of implementing NIC projects by reducing the reporting requirements. We also

explain how we propose to make it easier to access data gathered in the course of

NIC and NIA projects.


Issue Proposed change Rationale

We recognise that some aspects of the NIC and NIA have been overly burdensome on network companies and participants, the

following proposed changes are intended to reduce the regulatory and administrative burden of participation in the NIC and NIA.

NIC alternate bank

account

Remove requirement for Ofgem to

approve use of alternative bank

account arrangements – but retain

other requirements.

So long as all criteria within Governance Document are fulfilled there

is no need for Ofgem to be involved. This would reduce the resource

requirements of the network companies and of Ofgem.

Merge the ongoing

NIC and NIA projects

reports

Require an annual NIC report covering

all of a company’s NIC projects and

allow for this to be within the same

document as companies’ annual

summary of NIA activity.

Allowing companies to combine all the learning from their innovation

projects in a year within a single document would reduce the burden

on network companies as well as making the learning from projects

more accessible for interested parties who would only need to review

a single document to understand exactly what a company has done in

a given period.

Remove the need in

the NIC and NIA for

customer

engagement and

data protection plans

No longer require approval of Customer

Engagement and Data Protection Plans.

Maintain requirements not to interfere

with Smart Meter rollout and not to

conduct sales activities as part of trials.

We don’t think our approval of Customer Engagement Plans adds

value – they merely state what data network companies plan to

collect from participants in trials and how they plan to engage with

different parties. The Data Protection Act places necessary obligations

on companies and we are not experts in customer engagement.

Cross sector projects

in the NIC

Joint assessment of projects requiring

funding from the gas and electricity

NICs – single submission to both

competitions and joint meetings of the

gas and electricity Expert Panels to

consider cross sector projects.

This would reduce the resource requirements on network companies

by requiring them to complete a single full submission document

which would be applicable to both competitions. In addition, holding

joint meetings of the Expert Panels to consider cross sector projects

would reduce the resource intensity for network companies and

Ofgem.

The following proposed changes are intended to ensure the data from projects is accessible to interested parties and that innovation

makes its way in to the business as usual (BAU) activities of network companies

Sharing of NIC and

NIA learning

Require network companies to have

systems in place to be able to share

data collected from trials (anonymised

where necessary).

Data gathered through innovation projects could have value beyond

the initial project it was gathered for. Consumers have funded the

gathering of this data, therefore they should be able to get the

maximum value from their investment.

Rollout of NIC and

NIA projects into

BAU

Require better reporting, through the

Regulatory Instructions and Guidance

by network companies on BAU potential

and plans for each project undertaken

by themselves and other network

Encourage greater take up of other network companies’ projects that

could deliver GB-wide benefits. Put us in a stronger position when

setting the next round of RIIO 2 price controls.

The Network Innovation Review

35

Issue Proposed change Rationale

companies. Also capture future

expected benefits when rolled out. As

part of this work we will ask network

companies to explain what ideas that

have been developed will be taken

forward or not and why. We will also

ask them to explain the scale of any

proposed rollouts and the forecast

benefits.

The following changes are intended to ensure better compliance with the NIA governance document.

NIA governance

compliance

Require companies to justify why a

project is eligible and ensure senior

level sign off of project registration

documents.

Currently the companies just have to tick the relevant box to say why

they consider it eligible. Due to concerns identified over some

projects, we propose that relevant network companies should justify

more explicitly why projects are eligible and innovative (as they do for

the competitions).


6. Next steps

In this document, we have set out our proposals for the NIC and NIA, including the

contribution to the electricity NIC from the electricity distribution price control over

2017 - 2023. We are seeking stakeholders’ views on these proposals to assist us in

deciding the way forward.

We welcome responses to the issues we have raised or closely other related issues

by 6 February 2018. Responses should be sent preferably by email, to

[email protected] or in writing to

Neil Copeland

Ofgem

Third Floor

107 West Regent Street

Glasgow

G2 2BA

If you wish to have your response remain confidential, please clearly mark the

document to that effect. Unless marked confidential, all responses will be published

on our website in the usual way.

In early December we plan to consult on the draft legal text for implementing our

proposals – including changes giving effect to our decision on the funding return

mechanism. 15 If stakeholders support our policy proposals, this should reduce the

amount of time required to implement changes to the governance arrangements and

any licence changes.

We plan to hold an Innovation Working Group on 11 January 2017, at our London

offices, to discuss our proposals and rationale. We also intend to discuss the

proposed draft legal text. Please email [email protected], if you

would like to attend this session or require further information.

We expect to publish our final decision in spring next year. As noted in this

consultation, some of our changes will take effect next year but others will not take

effect until the 2018 NICs.

15 https://www.ofgem.gov.uk/publications-and-updates/proposed-modification-funding-return-mechanism-network-innovation-competition-and-low-carbon-networks-fund-licence-conditions



https://www.ofgem.gov.uk/publications-and-updates/proposed-modification-funding-return-mechanism-network-innovation-competition-and-low-carbon-networks-fund-licence-conditions

https://www.ofgem.gov.uk/publications-and-updates/proposed-modification-funding-return-mechanism-network-innovation-competition-and-low-carbon-networks-fund-licence-conditions


37

Appendices

Index

Appendix Name of Appendix Page Number

1 Summary of responses to December 2015

consultation 38

2 Feedback questionnaire 41


38

Appendix 1 – Summary of responses to

our December 2015 consultation

A1.1 In December 2015 we published a consultation letter16 to begin our

innovation reviews. We received twenty nine responses, four of which were

confidential. We have published the non-confidential responses on our consultation

page. A short summary is included below.

Question 1: Should we change the NIC and NIA criteria? If so, how and

why?

A1.2 Thirteen respondents voiced support for the current mechanism and said that

it generally worked well, with exceptions or potential modifications, to enhance the

working of the criteria. Five did not provide comments to this question. Suggested

modifications included lengthening of timescales or introducing flexibility to

encourage lower TRL projects which need more time and widening benefits beyond

the carbon plan, which is seen as a barrier to projects innovating around customer

service or operating efficiency and could be a hindrance to companies addressing the

full market “trilemma17”.

Question 2: Should we give more of an indication of where we consider

innovation is required or is that inappropriate?

A1.3 There was a clear split between respondents on whether there should be any

direction offered by Ofgem on areas for innovation.

Those in favour of a direction being indicated by Ofgem, felt it would be a

catalyst for change.

Those who were neutral, pointed to the need for more robust communication

channels and data to inform strategic decisions industry wide.

Those against this idea, felt that network companies were best placed to

decide the most important directions for innovation; that the Expert Panel

provided a sufficient steer or that any fixed direction could stifle innovation.

Question 3: Should the focus of the NIC and NIA be broader and cover the

broader energy system?

A1.4 Eight respondents felt the current regime was fit for purpose. One commented

that it already provided scope for wider systems related projects and another, that

such wider-scope projects already funded, had “undershot” on their goals. It was felt

that it would be difficult to incentivise companies to work under a broader scope if no

benefits would be directly realised by them, and that a wider scope could distract

from the benefits that can be realised by customers through the current scope.

16 https://www.ofgem.gov.uk/publications-and-updates/reviewing-benefits-low-carbon-networks-fund-and-governance-network-innovation-competition-and-network-innovation-allowance 17 The energy trilemma is expressed as the challenge of reducing energy costs and maintaining security of supply whilst lowering carbon emissions.

https://www.ofgem.gov.uk/publications-and-updates/reviewing-benefits-low-carbon-networks-fund-and-governance-network-innovation-competition-and-network-innovation-allowance

https://www.ofgem.gov.uk/publications-and-updates/reviewing-benefits-low-carbon-networks-fund-and-governance-network-innovation-competition-and-network-innovation-allowance


39

A1.5 Fifteen respondents were in favour of broadening the scope on some level, ie

for third party access; to reduce current “artificial barriers”. However, many

conceded that the regulatory challenges to realise a wider scope, would be

significant.

Question 4: Can we improve the process for deciding on which projects to

approve and if so how?

A1.6 Nine respondents considered the process on the whole seemed to be working,

though some suggested areas for improvement. Generally it was considered that

whilst the process was bureaucratic, some parties welcomed the rigour and some

cited that notification of submission dates and other expectations were timely.

A1.7 Thirteen respondents provided various suggestions for improvement to the

current process. These included: improvements to the overall process: it was felt to

be a very intensive process with short turnaround times—this was seen as a

deterrent to small and medium sized enterprises trying to get involved. Too much

emphasis on academic rigour, governance, rigid deliverables and timescales was

seen as an issue. It meant projects might be project management heavy, rather than

being designed to produce replicable outcomes and learning for the real world.

Question 5: How can we improve participation in the NIC?

A1.8 Nineteen respondents raised comments under this question. Most commented

that the IP arrangements were a barrier to participation. However, the concerns

raised largely focussed on the NIA rather than the NIC.

A1.9 However, some noted that the NIC guidance had changed over time,

hardening the approach towards IP, which previously may have been more

favourable. It called for it to be reverted back. It was felt that to make DNOs solely

responsible for foreground IP, prevents partners from extracting any future revenue

from this IP - both on a GB and worldwide scale. One respondent noted a reluctance

in the innovation community to participate in RIIO innovation projects because of

issues with IP.

A1.10 One respondent suggested an investment pay-back before the IP can be

commercialised. An industry group suggested IP should be reviewed in relation to

both the practical issues of recording/ holding IP rights and with being the best party

to exploit it. At present there are significant costs for network companies associated

with this and IP should not default directly to the network operator.

Question 6: Please comment on your experiences if you have worked with

licensees when implementing NIC and NIA projects or when transferring

innovation into business as usual.

A1.11 Generally, experiences were positive for those who had worked on NIC and

NIA projects. Specifically, those who had been partners on projects, cited good

working relationships being forged with network companies.

A1.12 However, some commented on the slow progress of deployment, ie heavier

focus on project delivery, rather than consciousness or funds available to purchase

and implement the resultant technology, slow pace of BAU and need to improve

collaboration and knowledge dissemination (the latter is specifically frustrating when

learning is not taken as sufficient for adoption by other companies, which delays any

roll out potential).


40

Question 7: Are there any other issues we and the independent evaluator

should consider as part of the review?

A1.13 Respondents raised a number of issues, including:

the perceived but marked reduction in ambition of innovation projects

There are only two application windows for the Innovation Rollout Mechanism

in each price control period - suggest more flexibility through more windows

and a reduction in the materiality threshold - would allow more innovations to

be deployed on the network.

There is a need for planning to establish how projects which may not finish

before the end of the price control window are to be transitioned into the new

regime.

The current scheme is innovative but risks being limited if it cannot resolve

how to encourage outsiders and out of the box thinking. Important to consider the potential savings for DNOs in the future - review

should consider benefits over the full lifetime of the assets developed.

Question 8: To what extent do you consider that the LCN Fund has

succeeded?

A1.14 Fourteen respondents stated that the LCNF had been a success or had

wrought benefits (eg lower bills to consumers). Two pointed out that the LCNF was a

success due to it building on the IFI which itself was seen as a successful foundation.

Several noted the significant impact the LCNF had had in generating learning, but

one caveats this with the lack of proper synthesis of learning to encourage BAU and

delay in proper dissemination of knowledge.

A1.15 Some respondents noted that it might be too early to tell given that

deployment of the technologies was not complete. Respondents noted that our

review should be mindful of the different energy landscape that the LCNF operated

in.

Question 9: To what extent do we need to continue incentivising innovation

by DNOs?

A1.16 All those who responded to this question, came out in favour of continuing to

incentivise innovation.

Question 10: Are there any other issues we need to consider as part of the

LCN Fund benefits review?

A1.17 Most of the comments raised under this question were felt to be more

relevant to the review of the NIC and NIA, and have been incorporated in summaries

of questions 1-6, above.


41

Appendix 2 - Feedback Questionnaire

Ofgem considers that consultation is at the heart of good policy development. We are

keen to consider any comments or complaints about the manner in which this

consultation has been conducted. In any case we would be keen to get your answers

to the following questions:

1. Do you have any comments about the overall process, which was adopted for this

consultation?

2. Do you have any comments about the overall tone and content of the report?

3. Was the report easy to read and understand, could it have been better written?

4. To what extent did the report’s conclusions provide a balanced view?

5. To what extent did the report make reasoned recommendations for

improvement?

6. Please add any further comments?

Please send your comments to:

Andrew MacFaul

Consultation Co-ordinator

Ofgem

9 Millbank

London

SW1P 3GE

[email protected]


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